Form W-4 Exempt Error…Whose at Fault? Who Should Pay?

The Form W-4 is one of the basic forms that payroll must handle during the course of a normal payroll processing. But that doesn’t mean it is not an important document that needs to be processed with care and diligence. And as with all things, payroll is human and can make mistakes. But if a mistake is made on inputting a Form W-4–say going from exempt back to having taxes withheld– who should “pay” for the error…the employee who didn’t catch the error for the entire tax year, or the payroll person (employer) who made it and didn’t follow up with an edit? This is one of those questions that seems like it can go either way. For some will respond (usually payroll professionals) by saying that the employee should have noticed that taxes were not being withheld and said something before the end of the year. But others (usually the employee) will say it is payroll’s fault therefore they should be responsible for my taxes being correct since I did submit a valid Form W-4 as required by the IRS. It can be argued that since the employee was not deprived of any money he should have the means to pay his taxes. However, that being said, the catch is if the employee is underwithheld the IRS can assess a penalty against the taxpayer (employee). In turn, the taxpayer (employee) could report the employer is at fault for failing to withhold. Under a IRS Office of Chief Counsel letter released on 9/30/11 it appears the IRS would side with the employee as regards to the penalties. See the excerpt from the letter below.

So what is the answer to the question? Unfortunately it is the same as with all payroll questions…avoid making the mistake in the first place. Don’t take the “easy” tasks for granted. Have edits in place to ensure that all Forms W-4 are audited before and after they are input into the payroll system. And as I have always done on my payrolls after finding out that my staff has made such mistakes, implement a program to verify all exempt employees each quarter not just unless the employee complains. I have found that running a list of exempt employees each quarter and taking the extra time to verify they still want to be exempt goes a long way towards catching these errors. This is especially true during this time of the year when many employees who claimed exempt in 2015 are not doing so in 2016. For this is when the errors are more likely to occur.